Bold Thinking or Complete Nonsense?

It's time for bold thinking in this economy...

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Shiller's article, which appeared in the New York Times, begins with the idea that housing prices may decline 30% or more just as they did from 1925-1933. On that I agree. After some history about what happened under the FDR administration, Shiller suddenly dives off the deep end with some proposals to "fix" the problem.

For example, please consider:

In light of modern financial theory, this would also be a good time to think about the nature of the implicit subsidies given to government-sponsored enterprises like Fannie Mae (FNM) and Freddie Mac (FRE) and whether they provide enough incentives for them to properly manage their own risks as guarantors of mortgages.

We should think about whether the F.H.A. should be encouraged to take on a bigger role that might compete with activities of the subprime lenders that have grown so rapidly over the last decade.

We might create a new consumer-oriented regulatory authority, like the Financial Products Safety Commission that Elizabeth Warren, a professor at Harvard Law School, has been advocating. It would monitor financial products for consumers and draft regulations to prevent practices like the recent widespread issuance of adjustable-rate mortgages to low-income borrowers who couldn't afford the rate resets.

Shiller goes on to say:

Beyond that, we should think creatively about how to use vastly improved tools for risk management and apply them to mortgages. For example, I and my colleague Allan Weiss (now C.E.O. of Index Capital Advisors) proposed in 1994 to make home equity insurance - insurance on the market value of a home - part of a home mortgage contract. Had our proposal been put into place on a large scale, it would have gone a long way toward ameliorating the current crisis and reducing the need for personal bankruptcies.

The problem is that all this proposal does is shift risk from one entity to another. On the surface, homeowners would be protected but who is protecting the insurance company?

One good look at the complete collapse of Ambac (ABK) and MBIA (MBI) should be enough to highlight the problem: Insurance is only good if the insurer can pay out.

In this case, anyone insuring the value of houses would have long ago failed, putting the burden right back on the homeowner. That is the seen. The unseen is belief that such a scheme could possibly work would likely have led to an even bigger bubble than we saw.

Root Causes Of The Housing Bubble

1) The Creation of GSEs

Does anyone even remember the mission of the GSEs? It is to promote "affordable housing." Now there are proposals in Congress and supported by Bernanke to allow Fannie Mae (FNM) and Freddie Mac (FRE) to make loans up to $1,000,000. Is this affordable housing or complete insanity?

2) Government Sponsorship of the Ownership Society

Government sponsorship and promotion of housing including some 300-odd programs to make "housing affordable" have had the opposite affect. Government has no business promoting housing over renting or making people feel like second-class citizens for not owning a home.

3) The Greenspan Fed Slashing Interest Rates to 1%

Banks mistakenly assumed the difference between the rate at which they borrowed and lent would cover problems. In addition, banks had repeatedly learned that the Fed would bail out their mistakes. This led to extreme reckless lending, including Citigroup (C) CEO Chuck Prince dancing like a fool in summer of 2007 right as everything was starting to collapse.

Like Bernanke, Shiller seems to be confused about what caused the Great Depression. The cause was an expansion of money and credit leading up to the collapse. Nowhere in Shiller's proposals does he address the cause of the housing bubble or the cause of the depression.

The four points above are really sub-bullets to the greater thesis: Reckless expansion of money and credit eventually leads to collapse.

I am extremely disappointed in this socialist approach to the problem proposed by Shiller. Instead of addressing the root causes, Shiller wants to try the same failed ideas of still greater government intervention into free markets.

Still, I agree with Shiller on one key idea: It's time for bold thinking. For those who want to try something really different and something that will actually work, I suggest...

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